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France. Europe’s biggest problem… and its solution

Forget about Brexit or Trump. The big problem that threatens the European Union is France.

The French elections are much more important to the future of the EU than any other global geopolitical event.

On Monday we will know in detail the economic programs of the main candidates, but unfortunately, we can imagine that most promises will come on the side of increasing imbalances and magic solutions. Announcing reforms that are not followed and continue with an unsustainable model of stagnation has become the norm.

Of course, Le Pen promises to get out of the Euro in an orderly fashion, which is like saying that you’re going to stab yourself gently. A joke. Proponents of populism always try to solve structural problems destroying the country, devaluing and decimating the middle class with rampant inflation.

France is both the big problem and the solution for Europe. An unsustainable economic model that presidential candidate Macron himself has called “sclerotic“.

A huge part of the problem is a public sector that exceeds 22% of the workforce and accounts for almost 48% of the budget, with one of the largest public expenditures of the OECD – the seventh largest in the world. But that would not be a problem if the country grew and improved its international position. The serious mistake is that this model of “directed economy”, socialist no matter who wins, has led to stagnation for more than two decades, high debt and excessive deficits for a leading economy and, in addition, France has been losing positions relative to Germany, its main comparable.

The other challenge is that, in order to finance this huge public expenditure, it always raises taxes, with a tax burden that is the highest in the Eurozone. A labour market rigidity and tax burden that limits growth, business creation, employment and competitiveness.

Despite constant tax increases, the country continues to miss its deficit targets because the economy, after a few brief quarters of hope, falls again and again into stagnation.

France has not only seen its exports lose weight globally, but its neighbour Germany reach a record historical trade surplus while reducing unemployment to all-time lows. That is, almost full employment.

The worst is that the massive labour rigidity does not protect, and youth unemployment remains above 24%, France’s unemployment rate is double that of Germany or the UK, and it creates fewer jobs than any of its comparable economies. The government itself recognises that between 1998 and 2015, labour costs have risen by more than 50% but productivity has barely grown by 20%.

It is worrying and at the same time sad that much of the French parliament, instead of analysing the weakening economic power versus Germany or the world’s leading countries, prefers to justify itself stating that peripheral countries fare worse.

On Thursday I was in a conference on the Brexit opportunities with representatives of the main cities bidding to attract capital from the process, Frankfurt, Paris and Dublin. The representative of Paris, when asked about labour rigidity and high taxes, could only respond diplomatically, saying that France offered “security.” A member of the audience later commented “security that taxes will rise”.

But France is also the solution for Europe. It has all the ingredients to carry out a revolution like the one that Schroder carried out in Germany, taking the country from being the “sick man of Europe” to the leader of the continent. It can set in motion a real reform plan that puts France in par with leading economies, not justifying itself with the data of the worst performers.

If France recovers its economic leadership by putting competitiveness, attracting capital, strengthening disposable income, cutting axes and spending slack, and eliminating the perverse incentives of the dinosaur conglomerates, it will save Europe.

If France insists on remaining in denial, and ignore the imbalances that separate it each year further from the leading economies, it will destroy the European Union. Because, meanwhile, the “aristocrats of public spending” and the governments of the periphery compare themselves with France, as always, in how much spending and taxes have to rise, with the slogan that “we are below average.” An EU average that disproportionately rises because of France, and leads others to perpetuate, with the applause of populists, wasteful spend, debt and becoming a tax hell. Meanwhile, France perpetuates its stagnation with the excuse that the periphery does worse. It looks like a competition of students to see who fails more exams, only to blame the teacher.

If France thinks that denying reality and perpetuating an unsustainable model will be solved with magic solutions of printing money and devaluing, it will fail -again- and destroy the EU with it.

No, the problem of Europe and the euro is not Brexit nor Trump. It’s France. The problem, and the solution.

Daniel Lacalle is PhD in Economics and author of “Life In The Financial Markets”, “The Energy World Is Flat” (Wiley) and forthcoming “Escape from the Central Bank Trap”.

Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Frequent collaborator with CNBC, Hedgeye, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE. Siga leyendo.